Crypto's GENIUS Idea For the Next Financial Crisis
The industry that championed decentralization just begged for permission, and that's the problem
Amidst the chaotic news cycle of Jeffrey Epstein, tariffs, and starvation in Gaza, it’s understandable if you missed one of the most important legislative moves of President Donald Trump’s second term — the GENIUS Act. It stands for “Guiding and Establishing National Innovation for U.S. Stablecoins.”
The act provides a framework for modernizing our archaic payments system by allowing practically anyone to issue a stand-alone stablecoin. There are various requirements to ensure each coin is backed one-to-one with U.S. dollar assets (cash or cash equivalents like U.S. Treasuries), in addition to periodically publishing and auditing the composition of those reserves.
But while there is a definite need for faster and lower cost payments, not all “innovation” is good. Especially when used as a veneer for what are really tried, tested, and failed financial solutions from the 19th century and early 2000s.
I was highly critical of how the Biden administration chose (not) to regulate the crypto industry. How his henchman, Gary Gensler, at the U.S. Securities and Exchange Commission issued nonstop enforcement actions, but little guidance. And I’ve previously published ideas for how we could better regulate crypto while championing innovation.
The way not to do that is by repeating lessons we should have learned in the 1850s and 2007-08. The only difference this time is a blockchain wrapper and the guise of “innovative technology.”
Proponents of the GENIUS Act argue that it provides more regulatory certainty for the crypto industry, treating stablecoins as a means of payment rather than securities. It sets forth rules for issuers to follow, including keeping holders’ money in safe reserve assets like Treasury bills and bank accounts. Issuers must publish the composition of these reserves on a monthly basis. And any issuers with a market capitalization over fifty billion dollars must publish audited financial statements annually.
All of this may sound good until considering how the crypto industry begged for this regulation. This echos what the derivatives industry did in its efforts to gain the government’s seal of approval, culminating in the Commodity Futures Modernization Act (CFMA) of 2000. What the CFMA did was actually weaken oversight of derivatives, a failure that became vividly apparent during the global financial crisis of 2007-08.
It’s ironic that an industry like crypto, which long argued for its decentralized value outside the control of big banks and governments, has now embraced regulation and its entrance into more traditional finance. With the passage of the GENIUS Act, practically anyone (including the President) will be able to issue a regulated stablecoin, bringing back an era of private banking (known as “wildcat banking”) from America’s pre-Civil War era; an era that was plagued with frequent bank runs and bank failures.
Is it genius to attempt 19th century finance through stablecoins?
One of the more amusing attributes of the crypto industry is how surprised they act when giant frauds occur or when criminals use their technology for illicit means. As if the risks were novel and unforeseen. The reality, of course, is much different — traditional finance has faced many of these risks and challenges for centuries.
Practically every asset class has endured painful periods of maturation, whether it’s equities (Great Depression), bonds (see the junk bond king), options (binary options fraud), or derivatives (2007-08 financial crisis). To think that crypto is somehow magically unique and exempt from these historical trends and traditional finance risks is untethered to reality.
So when something like the GENIUS Act comes along we should be immediately skeptical. First, for the reason stated earlier — the industry welcoming regulation. They typically will only do this when it’s obviously in their self-interest. And second, when legislation legitimizes activities under a new name (stablecoins) that carry many of the same risks that President Abraham Lincoln of all people had to deal with in the 1860s, alarm bells should be ringing.
The pre-Civil War banking system in America relied on numerous private banks that issued their own currencies. Businesses and depositors had to decide who to trust. State laws largely determined the degree of regulation and oversight. So while certain states like New York had few problems, other states with laxer rules like Michigan experienced numerous bank runs and defaults.
This era came to be known as “wildcat banking” because businesses and ordinary people didn’t know who to trust amongst all the different forms of currency. The value of money fluctuated widely. To mitigate the chaos and help finance the war effort, Lincoln signed the National Banking Acts of 1863 and 1864. These acts led to the creation of a uniform, national currency. They also required higher capital and reserve standards for banks so they could better survive higher volatility.
We learned in the 1860s that private banking, where every bank issued its own currency, created too much chaos, uncertainty, and failure in the financial system. Yet somehow the current Congress and Trump administration think this time it will be different with stablecoins. But the market structure for stablecoins under the GENIUS Act is effectively the same.
Practically anyone can now become a stand-alone stablecoin issuer. Just as any bank in America could issue their own currency prior to the 1860s. But now it will be on the blockchain in the form of Bezos bucks, Elon bucks, or [insert your favorite billionaire] bucks. Even President Trump has issued a stablecoin while simultaneously being President!
The fact conflicts of interest don’t apply to the President or Vice President under the GENIUS Act is a topic for another story.
The glaring problem here — aside from mass confusion on what stablecoin to use when — is that there is no guarantee that all of these stablecoins will be worth $1 per coin. Just as there was wild currency volatility in the 19th century era of private monies, there will inevitably be volatility in the 21st century era of stablecoins. No amount of crypto evangelism will save us from basic economics, especially if interest rates were to rise as they did in 2022 and 2023.
In case you don’t believe me, look at the price history of the two most widely used stablecoins to date — Tether and Circle. Tether fell to 95 cents in May 2022 and during the 2023 Silicon Valley Bank crisis, Circle’s USDC coin fell below 87 cents.
So assuming issuers, auditors, and regulators all do the right thing at peak efficiency — with zero fraud, manipulation, and misconduct — it’s still impossible to escape periods of volatility and uncertainty that add stress to the system. And we know from history that there likely will be fraud, manipulation, and misconduct in the market (just ask Sam Bankman-Fried).
It’s also important to note that the prices I quoted above (95 cents and 87 cents) are in U.S. Dollars. Because in the end, this stablecoin regulatory framework is directly connected to dollars, whether in cash or cash equivalents (e.g., U.S. Treasury bills). While some may champion this as a win for U.S. dollar supremacy, the compliance officer in me wants to focus on the contagion risk.
As with the derivatives and mortgage crisis that blew up in 2007-08, this new stablecoin regime under the GENIUS Act has the systemic potential to compromise the entire financial system.
The contagion ghost of the financial crisis could haunt stablecoins
The Office of the Comptroller of the Currency (OCC), a division within the U.S. Treasury Department, is responsible for policing the entire stand-alone stablecoin issuer market. If any of these firms become chartered banks, more regulators like the Federal Reserve and the Federal Deposit Insurance Corporation will have oversight, but for now, the onus is primarily on the OCC to make sure this operates smoothly.
And that’s a huge ask. For if stablecoins expand greatly under this new regime, with big banks entering the fray as many have said they will, there will be more bank accounts that hold assets to back the stablecoins in the market. While this conceivably could improve our archaic global payments system that still runs on 1970s technology, it also significantly increases the risk of bank runs.
The crypto ecosystem is anything but stable. As noted, even the stablecoin market has endured recent periods of volatility where coins lost their dollar parity “stability.” And now the stablecoin market’s formalized connection to traditional financial creates serious contagion risk. Should volatility spike due to a rise in interest rates, loss of consumer confidence, or some other economic driver, it will impact far more than the stablecoins themselves.
Stablecoin holders would likely rush to convert their coins into actual cash. If stablecoins are backed by U.S. Treasuries, then that could spark a sell-off in U.S. government securities, causing their prices to plummet. It would force firms like Tether to sell Treasuries into a down market to cover redemptions.
The contagion effect is similar to what happened during the 2007-08 financial crisis where mortgage defaults set off a chain reaction that affected mortgage-backed securities, collateralized debt obligation, credit default swaps, and even the insurance products issued on those securities and derivatives. The entire system came crashing down and had to be bailed out by the U.S. taxpayer to avoid complete economic collapse.
There are no existing guardrails in the GENIUS Act to mitigate contagion. The capital requirements are minimal — a one-to-one correspondence to the dollar for every coin. There are no extra requirements should market conditions drastically change or bond prices fall.
Unlike the 19th century where bank failures were largely isolated events, the 2007-08 financial crisis demonstrated the interconnectedness of the modern system. Add hundreds or thousands of stablecoins to the mix all backed by the same assets and it’s impossible to ignore the vast web of connections. One pocket of instability could detrimentally affect the entire system.
What we witnessed with the collapse of Silicon Valley Bank was a concentration of similarly situated customers who spread rumors in group chats and on social media, sparking a bank run that led to the bank’s almost immediate demise. If regulators failed to monitor and prevent that collapse, how can we be comfortable as taxpayers that the (already stretched too thin) OCC can proactively police the burgeoning stablecoin market?
And the market for stablecoins is just getting started, similar to where derivatives were before their rapid growth after the CFMA passed. Instead of financial innovation in derivatives, we experienced a seven-fold increase in poorly regulated credit default swaps that helped spark the 2007-08 financial crisis.
All it would take is customers of one stablecoin to lose confidence, spread those ideas on social media, and for the market to seek redemption of not only that specific coin but many others. This in turn would spark a mass selloff in U.S. Treasuries, spiking interest rates (which are inversely correlated to price), and significantly increasing borrowing costs for everyone. It would also pressure Main Street to bail out speculators as was the case in 2007-08.
A not so GENIUS first step
It’s important to caveat that this is only one step towards the larger regulatory framework for crypto. But it’s hardly a genius one despite it being a largely bipartisan effort, with 102 Democrats voting alongside Republicans in the House to pass the bill. Congress is currently working towards creating a broader crypto regulatory framework.
So time will tell whether lawmakers can recognize the serious contagion risks and vast amounts of uncertainty they’ve unleashed through 19th century banking strategies. Or whether they’ll actually restrict the President from personally enriching himself and his family while giving legislative legitimacy to these markets (the market cap of President Trump’s stablecoin, USD1, is currently around $2.2 billion).
I want to believe that the GENIUS Act will support the U.S. Dollar and the U.S. Treasury market as its proponents argue. I want to believe this act will lead to the innovation we need to upgrade our antiquated payments system that’s too reliant on outdated technologies like SWIFT. I also hope that the confusion numerous stablecoins will likely cause is simply overblown.
But history suggests it isn’t. History from the 19th century indicates that this type of wildcat banking adds more uncertainty and volatility to the system, not less. History showed us what can happen when contagion risk is underestimated or ignored when giving “innovative” financial products like derivatives regulatory stamps of approval with few guardrails.
It’s simply too much to expect perfection in this type of stablecoin payments system. We cannot assume that one stablecoin will always be “stable” and equal one U.S. dollar. We cannot assume that the price will never fluctuate widely, if at all. Or that cute accounting approaches won’t find ways to reclassify certain assets backing the stablecoins. Or that auditors and regulators will always effectively check stablecoin issuers and not be “captured” by them.
I know that this level of expected perfection won’t happen because it hasn’t happened with any other asset class in the past. I know it will likely fail because it’s using 19th century approaches for 21st century technology. And government has agreed to regulate the industry in the way it requested that removes most oversight and ignores contagion risk in the same way the CFMA did for derivatives in 2000.
When we should instead be developing minimum standards for the industry around market structure (so a FTX situation can’t happen again) or implementing customer protection rules that exist in traditional finance, but making them applicable to crypto, we’re unleashing hundreds (if not thousands) of stablecoins on the masses.
It doesn’t take a genius to see how this story will likely end.
I want to believe that the $34T debt is not going to be converted to one crypto coin in the dead of night!